October 21, 2021

Asia

CHINA: Power shortages lead to durable market reforms

BY Gabriel Wildau

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( 5 mins)
  • Severe power rationing has led to significant long-term reforms to China’s electricity pricing system that go beyond emergency stop-gap measures.
  • Under the new system, coal-powered generators can pass on higher coal prices to electricity users; the changes also force coal generators into direct competition from lower-priced renewables.
  • Still, the Communist Party’s short-term focus on shoring up energy security and discouraging drastic action by local officials to meet emissions targets creates difficult optics ahead of COP26.

Our previous note on power rationing asked whether the short-term power crisis caused by surging coal prices would lead to durable reform of China’s rigid power pricing system, which has prevented coal-fired generators from passing on higher prices to electricity users. The answer appears to be yes. On 12 October, the National Development and Reform Commission (NDRC), China’s state planner, announced the most important liberalizations to China’s electricity pricing system since at least 2015.

Progress on market reform

Under the new policy, NDRC will allow coal-fired generators to raise prices for commercial and industrial users by up to 20% from the benchmark on-grid tariff. The previous limits, set in late 2019, were 10-15%. For energy- intensive users, which account for about 28% of total power consumption, there will be no limit at all. Moreover, the 20% limit applies only to futures contracts; the spot price in wholesale power markets will not be subject to any limit.

Beyond loosening price limits, the NDRC is also forcing most commercial and industrial users to buy power from futures trading markets instead of through private contracts with grid operators, where prices were set according to a fixed tariff schedule that often diverges from market prices. Only 44% of commercial and industrial users currently buy power in the open market, so the new requirement will force many to switch. All coal-fired power, which accounts for more than 60% of all power generation, must also now be sold through market trading.

Taken together, these reforms effectively end a system that indirectly promoted the use of coal power by insulating high-cost coal generators from market competition. Under that system, many provincial governments guaranteed coal generators a certain number of operating hours per year at a fixed price by requiring grid companies to buy from them. The new system exposes high-cost coal operators directly to price competition. Given that wind, solar, and hydroelectric power is now often cheaper than coal and gas, the new system will create incentives to rely more on existing renewable capacity and to choose low-cost renewables for future power plant construction.

Energy security vs decarbonization

Separate from the NDRC policy shift, top Communist Party leaders also discussed high-level principles for balancing energy security with carbon emissions reductions. The National Energy Commission, a high-level body designed to coordinate between various agencies, held a meeting on 9 October, only the commission’s fifth meeting since it was created in 2010. Premier Li Keqiang told the group that China’s transition to peak carbon requires a stable energy supply. He instructed local officials not to “jump the gun” on meeting emissions reduction targets and to avoid arbitrary limitations on power use. On the other hand, Li emphasized that President Xi Jinping’s previously announced goals of achieving peak carbon emissions by 2030 and net zero by 2060 remain high priorities.

Xi echoed this balanced message on 12 October, saying that China’s climate goals should be both “pragmatic” and “ambitious.” He also announced that construction has begun on projects to add about 100 gigawatts (GW) of wind and solar power in desert regions. That would exceed India’s entire wind and solar capacity and mark a substantial expansion in China, which had about 535 GW of such capacity at the end of 2020. Xi pledged in December that by 2030, solar and wind capacity would reach 1200 GW by 2030 and that non-fossil fuel energy (including hydro) would account for a quarter of primary energy consumption.

COP26 optics

Though Beijing has not retreated on any of its major climate commitments, the shift in focus towards energy security creates uncomfortable political optics ahead of COP26, which opens on 31 October. As previously discussed, authorities have taken short-term measures to contain surging coal prices by boosting output. These short-term measures seem to cut against the long-term effort to reduce reliance on coal. In addition, Xi, who has not left China in nearly two years, will not attend the conference. Though this decision mainly reflects Covid-19 concerns, Xi’s non-attendance may add to an impression that Beijing lacks commitment.

The recent power shortages also reduce the likelihood that Beijing will announce new pledges on carbon emissions at the conference, as Washington and others are urging, at least not beyond his recent promise to halt financing of overseas coal power projects. But as discussed, new pledges were unlikely even before the recent power crisis. Meanwhile, due to the reforms discussed above, the result of the crisis – at least for the long term – has been policy changes that raise electricity prices while promoting renewables over coal. We believe emissions reduction remains a high-level political priority.

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